Forecasting is becoming more difficult and less reliable for business planning purposes. Forecasting models are typically developed using historical patterns of behavior and of related events. There is often an unspoken ceteris paribus assumption that all things outside of the model hold constant but this is far reality.

In periods when exogenous forces of change move relatively slowly, such forecast models produce acceptably reliable projections. But the pace of change in exogenous forces affecting business has been increasing rapidly. These exogenous forces of change are increasingly impacting the effectiveness of planning in both the long-term and short-term.

The demand volatility that results leaves us with a choice: We either accept the risks of unexplained variation in our forecasts or adopt hedging strategies and plans that mitigate their effects. Hedging is a means of mitigation in the face of uncertainty. While hedging short-term risk across the company’s functional areas is important, hedging of long-term risks is essential to the very existence of the business. As with every business initiative there is a trade-off. Here it is the cost of hedging risk vs the benefit to be realized from the hedge. So, what are hedging strategies?

Types of Supply Chain Hedging Strategies

In Finance, for example, hedging is a risk management strategy employed to offset losses in investments by taking an opposite position in a related financial asset. In supply chain activities, hedging is often done trading in the commodities options markets to reduce the effects of price fluctuations in essential materials used to make the company’s products.

Insurance products are also an example. If a company buys property insurance, it is hedging itself self against fires, weather, or other unforeseen disasters. Similarly, this is the case with key-man insurance and officer liability insurance in business. In demand planning and supply chain forecasts and plans, inventory is often used as a short-term hedging strategy for uncertainty. Supplier selection and diversification can also be a hedging strategy. Some risks are insurable, which diversifies the risk sharing. Some risks are not insurable. So, portfolio managers, individual investors, and corporations use hedging techniques to reduce their exposure to various risks that they cannot directly control.

Identification of exogenous risk factors requires participation of experts from all areas of the business

Executive and senior management are responsible for the strategic and long-term plans of the company and for implementing hedges to deal with risks that exist within these plans. The first step in developing hedging strategies is to determine which forces of change are significant and are materially increasing financial, operational, or other short-term and long-term risk. Identification of significant exogenous factors requires participation of cross-functional members who are experts in the risks related to sales, marketing, operations, product development, demand planning, supply chain, inventory management, distribution, finance, and other key functional areas within the company.

Since these functional areas have unique risk characteristics but also affect each other, it is important to approach the question of material risks in a holistic manner. Any business forecasting and planning efforts will need to consider hedging strategies as they relate to the functional areas individually and collectively. So, structuring a process of cross-functional involvement is important to precluding siloed efforts which do not assess the cross-functional interaction of risk.

Risk assessment is usually initiated by executive management and undertaken by senior management across the functional areas

This risk assessment process phase generally happens as part of the strategic and long-term planning of a company. It is usually initiated by the executive management and is undertaken by senior management across the functional areas. The demand planning and supply chain functions are involved along with other functional areas, but the purpose is to orchestrate and integrate the risk assessments and hedging actions across the company. Finance and FP&A are heavily involved due to the monetization activity that is a part of this effort. Naturally, the finance functions of the company are usually an important part of the higher-level, long-term planning for which senior and executive management are responsible.

Exogenous Risk Categories

Each functional area should develop a list of exogenous risk categories that characterize their functional responsibility. These broad categories could be technological, environmental, competitive, political, financial, demographic, economic, market-related, etc. Within these broad categories, specific significant risks both short-term and long-term can be identified along with the degree of risk (e.g., extremely high, high, medium, moderate), expected effects and results, associated potential costs or profit loss, as well as potential hedging actions that may be considered. Hedging actions should consider resources required and potential costs and benefits of the hedging activities necessary to offset or partially offset the risk.

It is important that FP&A be involved to dollarize risks and actions

It is important that each participating functional area shares its results and findings with the other participating functional groups. Their coming together as a group to review and integrate their combined risk assessments is important in being able to prioritize different risks, assess the collective business effects, determine which can be hedged and to what degree, and to develop a plan of action that addresses the timely hedging of the most significant risk areas. It is important that FP&A be involved to dollarize risks and actions as well as support all of the functional areas in the translation of their findings into financial effects and financial plans.

Real-Life Examples of Hedging Risk

Example 1: Business Software

Let’s look at a real-world example. There is a global business systems company for which the R&D/Product Development function develops operating systems, hardware, and software for sale to multiple business types globally. The company funds these undertakings from an R&D budget that is funded as a percentage of corporate revenue. It was working on a replacement for an existing retail software product that had a tight introduction timeline given the existing product was close to the end of its lifecycle. Designing the replacement solution was complicated because there were multiple types of technology that could be used to build it. This presented uncertainty both in terms of performance and cost to build and roll out the replacement system.

So, the company hedged the technology risk with a multi-path development approach, starting three alternative projects simultaneously, from which the company would select the best option. There were periodic assessments of each project to evaluate progress. A date for a decision was set and, based on the findings, a final technology solution and product design was chosen from the three options and carried through to completion, abandoning the other two projects that did not make the cut.

This allowed the company to meet the market window timeline that was so important to the product introduction, and to choose the best technological alternative to ensure acceptance and product longevity in a competitive marketplace. The cost of the three projects was more than offset by the additional revenue and profit realized by hitting the market introduction window and in having a competitive technology solution.

Example 2: Food Service Industry

Another real-world risk hedge example is from the Food Service industry. There is a large midwestern restaurant industry corporation that had a growth plan for expanding its market penetration through a combination of franchising and company unit market development. It was a publicly traded company on the New York Stock Exchange, and its value in the market was materially influenced by investor expectations for the success of the growth plans of the company.

The company used regional vendors for getting supplies to the restaurant locations and would continue to expand this supply chain as market expansion continued. But there were signature products that were absolutely essential to the financial success of the restaurants, especially as expansion took place into new markets. Insufficient availability of these signature products from third party vendors as expansion occurred was a major risk to the success of the expansion plans.

So, to hedge the long-term Signature Product Risk, the company purchased a food processing operation in a strategic location in the geography of the growth area. The company would operate and control the food processing plant and its operations. It had the capacity to service all of the current locations as well additional locations as market expansion continued. It also had the potential to expand its processing capacity if market expansion exceeded currently planned levels.

As it turned out, this processing plant met market needs for a long period of time and supported the growth strategy, and even went on to expand its capacity as the company went beyond the original expansion plans. This provided a flexible and expandable hedge for the Signature Product Risk that could have affected the company brand positioning, the financial success of the restaurant operating units, and the success of the business expansion programs.

Top management support, buy-in across functional areas, and translating results into activity and financial plans is essential.

The best forum in which to drive the risk assessment and hedging efforts described above is the long-term business and strategic planning of the company. Top management support, buy-in across functional areas, and translating results into activity and financial plans is essential. It can add to the quality and effectiveness of the long-term and strategic planning processes in which senior and executive management is involved. It provides a framework for functional risk analysis, and hedging can be done for short-term risk hedging across the company’s functional areas.

The Bottom Line

As the speed and degree of change continues to become more of a factor in business forecasting and planning —  both short-term and long-term — company success and survival will require processes that are adaptive by nature to the risks that are affecting all businesses today. Hedging strategies are an important consideration in this increasingly volatile business environment. Assess the risks in your business forecasts and plans. Expect the unexpected. And hedge your bets.

This article first appeared in the fall 2023 issue of the Journal of Business Forecasting. To access the Journal, become an IBF member and get it delivered to your door every quarter, along with a host of memberships benefits including discounted conferences and training, exclusive workshops, and access to the entire IBF knowledge library. 

Demand forecasting and demand planning are foundational elements of business plans and business strategies across the many functions within the company. They encompass long-term planning, short-term planning, and everything in between.

They are key factors in Marketing Planning, Sales Planning, Supply Chain Planning, Product Development Planning, Capital Investment Decisions, Operations Planning, Inventory Planning, Financial Planning, and other business planning. They are critical elements in the development of short-term and long-term business strategies for the company and its functional areas.

Demand Planning is More Than S&OP

Many of the business decisions made throughout the company depend upon the insights, knowledge, and proficiency of Demand Planners. Demand Planners must be concerned with the business behavior affecting business-to-business product and service transactions, and with the consumer behavior of the ultimate product and service users. Demand forecasting and planning are disciplines that are applied well beyond their uses in the S&OP/IBP processes for the company.

“The Demand Planner must understand not only the company, its products and its businesses, but the context in which the company is operating”

The Demand Planner must understand not only the company, its products, and its businesses, but the context in which the company is conducting its business. This requires curiosity, vision, analytical skills (both static and dynamic), multi-time horizon adaptability, and the ability to work with others cross-functionally and across management hierarchies.  Demand Planners are imbedded in functions all across the company within the many functional responsibility areas. While their functional locations may vary, their profession has common important elements and considerations that are fundamental to the work that they do. What are some of these elements?

What Separates Great Demand Planners from the Merely Good

1. Understanding of the relevant industry, industry segments, and associated trends and developments
   2. Knowledge of minor, major and emerging competitors and their strategies and activities
   3. An understanding of economic conditions and trends affecting the company and its products and services sales – both domestic and global
   4. An understanding of political conditions and trends – domestic and global – which are affecting the company and its products and services
   5. A knowledge of demographic changes and trends affecting consumer demand for its products
   6. A knowledge of the key drivers of customer demand behaviors and that of consumers for the company’s products and services
   7. An ability to use technology and data sources ( internal and external) creatively and effectively for developing demand models, as well as performing demand analytics and for short-term, medium-term, and long-term projections of demand for use in business decisions and plans
   8. A knowledge of historical patterns of demand and emerging changes that might fundamentally affect demand through time
   9. A well-developed ability to communicate clearly and effectively across functions and management levels
   10. An ability to cohesively link all of the above to company goals – financial and non-financial – and to describe and explore the related business ramifications of scenarios, risks, and opportunities.

“Demand Planners represent a delicate balance of quantitative and qualitative skills”

The above elements should be carefully considered during the recruiting and hiring process for Demand Forecasters and Planners. These elements should be considerations in making promotions and compensation decisions. Demand Planners are an important resource within the company, affecting many of its business decisions and business processes. Their functional placement will vary with company organization structure. But their needed skills and abilities are commonly shared regardless of their functional placement. Demand Planners represent a delicate balance of quantitative and qualitative skills and of business perspectives that help them in the forecasting, planning, and strategic undertakings across the company.

To get up to speed with the fundamentals of Demand Planning and Forecasting, join IBF for our 2- or 3-day Boot Camp in Chicago from March 13-15. You’ll receive training in best practices from leading experts, designed to improve supply chain and enterprise performance. Super Early Bird Pricing is open now. Details and registration.

There are many factors that a demand forecaster must consider when developing a demand forecast. One of these factors is the pricing power of the company and of the brand. Pricing power will affect demand volume when prices change. It is important that the demand forecaster is familiar with pricing actions taken by the company and anticipate their impact on demand.

Price is an important element of the value perception of the customer/consumer. From a finance perspective, pricing power is also an important consideration for company investors where greater pricing power is typically rewarded with a higher company valuation and/or stock price.

What is Pricing Power?

If a company does not have much pricing power, an increase in their prices reduces demand for their products. A company that has substantial pricing power is often one that provides a rare or unique product with few rivals or substitutes in the market.

Scarcity of resources can also give a company high pricing power. If the resources for a product cannot be easily obtained, the price of those resources will increase because there is insufficient supply to meet demand, which pushes up the price of the final product for customers/consumers.

In these cases of pricing power, if the company raises its prices, the increase may not affect demand much – if at all – because there are no alternative products on the market that consumers can choose instead. So, when forecasting demand, the demand forecaster needs to consider the degree of pricing power the company has, as well as the degree of pricing power of the company’s competitors. A company’s pricing power is linked to price elasticity of demand for its products, a metric which can aid the demand forecaster in understanding how price changes will impact demand.

Price Elasticity

Price elasticity is a measure of the responsiveness of the quantity demanded of a product or service to a change in its selling price. It is calculated as the percentage change in demand volume divided by the percentage change in price. Price elasticity of demand can be classified into three categories: elastic, inelastic, and unitary. If the price elasticity of demand is greater than 1, the product is considered elastic, meaning that a small change in price leads to a large change in quantity demanded. If the price elasticity of demand is less than 1, the product is considered inelastic, meaning that a change in price has less or little effect on the quantity demanded (a strong brand will usually exhibit this characteristic.) If the price elasticity of demand is 1, it is unitary.

Apple iPhone: An Example of Price Inelasticity

An example of inelastic demand is the Apple iPhone. When the iPhone was initially introduced by Apple, the company had strong pricing power because it was essentially the only company offering a smartphone and associated apps. At the time, iPhones were expensive, and there were no rival devices. Even as the first competitor smartphones emerged, the iPhone still occupied the high end of the market in terms of pricing and expected quality.

As the rest of the industry began to catch up in service, quality, and app availability, Apple’s pricing power diminished. Apple began to offer new models of iPhones including cheaper models for budget-minded consumers. Even at that, Apple still reflects very favorable pricing power which contributes to its relatively high value as a high multiple of earnings in the stock market.

Cross Elasticity of Demand

Another metric of value to the demand forecaster is the cross elasticity of demand which measures the responsiveness in the quantity demanded of one product when the price for another product changes. Also called cross-price elasticity of demand, this measurement is calculated by taking the percentage change in demand volume of one product and dividing it by the percentage change in the price of the other product. (Companies often use cross elasticity of demand to determine and set prices of their products and services.)

Products with Perfect Substitutes: The demand forecaster can use the cross elasticity of demand to make comparisons of products that are considered perfect substitutes for one another or those that are complementary to one another. For substitute products, cross elasticity of demand remains positive, which means prices increase when demand for one product rises. Demand for complementary products drops when the price rises for another. This is called negative cross elasticity of demand. (Unrelated products do not affect one another.)

Products with no Substitutes: Products with no substitutes have the ability to be sold at higher prices because there is no cross-elasticity of demand to consider. Incremental price changes for products with substitutes can be analyzed to determine the appropriate level of demand desired and the associated price of the product.

Help Marketing & Sales in Their Pricing Decisions

The metrics above that relate to pricing power can also be used by the Financial Planning & Analysis (FP&A) function within the company to evaluate the financial effects (positive and negative) of pricing strategies and actions. Cooperation between demand forecasting and FP&A is important in aiding Marketing and Sales in their product pricing decisions. Pricing and pricing strategy is an important consideration for profitability and cashflow.

It is important for demand forecasters to understand demand and price interactions and inter-relationships within the product portfolio of the company and with competitor products in the marketplace. Price elasticity analytics can aid in their assessing the effects of promotions, pricing actions of the company, and the pricing actions of competitors. This is important to the demand forecaster’s effort to develop more accurate forecasts for use by management in the supply chain and other management processes of the company.

To get up to speed with the fundamentals of S&OP and IBP, join IBF for our 2- or 3-day Boot Camp in Miami, from Feb 6-8. You’ll receive training in best practices from leading experts, designed to make these processes a reality in your organization. Super Early Bird Pricing is open now. Details and registration.

It is a great time for business forecasting and planning and those who do it! We have technology and data analytics tools that could not have been imagined just 30 years ago. We have able to shift from manual, time-consuming data collection and analysis to enabling better business decisions quicker and easier, adding more value to our businesses.

It has been a time of great expansion of data, and of great advancement in forecasting tools to exploit it. We can better understand the purchasing behavior of customers and consumers. And we have better forecasting methods and models to generate demand forecast and revenue projections.

Demand Forecasters and Planners are now business partners in decision making across the entire enterprise – and that should be our goal.

Your Role Is Only Getting More Important

Operational and financial plans can are only as good as the underlying demand forecasts and plans. This places Demand Planners in uniquely important position, and one with great responsibility when it comes to the success of the company. Welcome to the 2020’s where Demand forecasting and demand planning are foundational. Welcome to a time of multi-dimensional business thinking. Having seen planning transition from a traditional approach of reverse engineering from the top line to the bottom-line performance, it’s like shifting from 2-dimensional chess to 3-dimensional chess.

Welcome to the 2020’s where Demand forecasting and demand planning are foundational

Shift Away From Short-Term Forecasting

What can we do to leverage the full range of capabilities available to us? Currently, a limiting factor for many is the continued use of spreadsheets. Spreadsheets are still widely used by Demand Planners in companies of all sizes. Spreadsheets require significant time to import data, maintain it, perform modeling, and export data for use in other software. Integrated software solutions within the company should be standard, freeing up time for Demand Planners to create insights of greater value to the company. Innumerable cost-benefit studies support this. Time is money.

It is important that time be dedicated to identifying and analyzing the drivers of demand

A Demand Planner’s time should shift from away purely performing short-term forecasting, for which Machine Learning (ML), and Artificial Intelligence (AI) can be readily deployed. If technology can assist in short term forecasting, what should we do with this extra time? It is important that time and effort be dedicated to identifying and analyzing the drivers of demand (and the forces that affecting these drivers), both now and in the future. This places the Demand Planner in a position to understand and anticipate bigger picture forces impacting the enterprise, and to inform and assist the strategic discussion and decision-making. That is enormously valuable.

Make Collaboration Your Superpower

Given all functions throughout the company plan and depend on demand forecasts and plans, development of relationships across functions is a major value-added. Become familiar with the terminology used by the functional areas participating in and using information from your demand forecasting and planning processes.

Help them to use the information you provide more effectively for their unique roles. Determine how you may be able to reshape information that you provide in a better format or segmentation structure. Ask them to share information with you from their functional area that may add to the effectiveness of the work in demand forecasting and planning, such as industry publications, research reports, market research, and other inside and outside information that they use.

Ask them about their views on events, situations, competitors, and other developments that impact their area of the business. Ask them how they might expect this to affect the company in the future. Ask them how it might affect their function in the future. Ask them to suggest conferences that they attend that they believe would add to the quality of the work that Demand Planners are doing. Ask and listen to inside and outside authoritative sources of information. Be genuinely interested in others and their functions.

Use Technology to Elevate Your Role to Business Partner

Implement technology solutions that enable better operational forecasts more quickly, while serving the company with insights and longer term forecasts that will drive strategic initiatives. Think of yourself as a trusted advisor for the company, aiming to deliver on enterprise goals and objectives and interested in its business success – and well qualified to guide the business in the right direction. This reframing of your role can enhance your value to the company and contribute to its future success and sustainability. Look constantly for ways to improve your functional area and the company as a whole.

Think of yourself as a trusted advisor for the company

As ML and AI develop in the coming years, they will likely be one of our best enablers and sources of rapid research and information for the work of demand forecasting and planning for future company success. The pace of change is rapid and unlikely to slow down in the future. Acquiring tools and applications that enable us to work more effectively and efficiently is essential. We should not fear technological developments but embrace them as they will be fundamental to our success, both as individuals and companies.

 There have been amazing changes for Demand Forecasters and Demand Planners in the past 25-30 years. And more change will come even faster in the next 5-10 years. It will be a great time and opportunity for business forecasting and business planning and for those who do it!

To get up to speed with the fundamentals of S&OP and IBP, join IBF for our 2- or 3-day Boot Camp in Miami, from Feb 6-8. You’ll receive training in best practices from leading experts, designed to make these processes a reality in your organization. Super Early Bird Pricing is open now. Details and registration.

Companies have been working on their 2023 business plans and budgets since the beginning of fall 2022. During this time, numerous developments have occurred in the economy and financial markets. One of the biggest concerns is rising interest rates around the world and how long they may remain elevated.

For the U.S Federal Reserve, the interest rate is expected to rise to 5.25-5.5% in 2023 and maintain that level until inflation is under control. Other central banks are taking similar actions around the globe. A U.S recession is expected in 2023, but its length and depth are uncertain.

Terminal interest rates will probably be held beyond 2023 and into 2024 – and perhaps even into 2025. Given the degree of uncertainty and global market risk, companies face numerous scenarios for which they must be prepared.

How Interest Rates Affect a Business

A key question for planning professionals is “How will interest rates affect my customers, my business, and my business operations?” Interest rate levels and changes can have both direct and indirect effects on a business and its customers.

1. They can affect the interest expense for financing working capital, such as inventory.

2. They can affect the financing cost of capital goods and capital projects.

3. They can affect the interest expense of rolling over debt when maturity has been reached.

4. They can affect the company’s cost of capital through interest expense directly and through investor expectation for equity returns as interest rates rise or fall.

5. They can affect the ROI hurdle rates used in making capital investment decisions and in product development projects.

6. They can affect the currency exchange rates faced by the company when buying and selling goods as well as those faced by the company’s customers.

7. They can affect the overall capital structure of the company through the relative proportion of debt financing and equity financing.

8. They can affect the interest costs for customers purchasing the company’s products, especially inventory and “big ticket” items like cars, trucks, and other capital assets.

So, interest rates and their effects are important considerations in many business scenarios for demand planning and Financial Planning & Analysis (FP&A) purposes.

Re-Evaluate Your 2023 Financial & Operating Plans

Any “approved” 2023 business plans, demand plans, budgets, and financial plans should be re-evaluated, and stress-tested to reflect how interest rate changes will affect the business and its customers. They may already be out of date.

Any adjustments to operational and financial plans should be made before implementing the financial reporting processes for 2023 to ensure that business metrics are utilizing a realistic set of goals, benchmarks, and budgets throughout the company. These should be periodically reviewed during the 2023 financial year. 2023 will be a time of changing business and market dynamics.

Interest Rates & Requests for Investment

When making requests for investment in product development, capital investments or new software, for example, it is important to consider the effect of changing ROI hurdle rates as interest rates change. The foundation of these ROI hurdle rates is the company’s cost of capital – debt and equity. The increase in interest rates into 2023 will have an associated effect increasing the investment ROI hurdle rates for the company so the justification for investments will require greater financial benefits. (ROI hurdle rates are also adjusted to reflect the degree of financial risk in investment types and so are modulated up and down to reflect this consideration.)

When requesting resources during 2023, it is important to work with the FP&A function to ensure that the request can be structured to meet the level of performance necessary to make the investment financially successful for the company.

2023 is upon us. It is essential that we be analytical and adaptive if we are to choose the best path towards operational and financial success. Understanding the impacts of interest rates is an important part of this effort.

To make S&OP/ IBP a reality in your organization, join us in Las Vegas for IBF’s S&OP/IBP Boot Camp. Running from February 15-17, 2023, it gets planning professionals up to speed with planning fundamentals and best practices. Complete with the chance to earn the world’s only S&OP/IBP certificate and 1-day Supply Planning Workshop. 

As of this writing, Central Banks’ efforts to reduce inflation are underway. Central Banks around the globe are increasing their interest rates in response to the rate increases by the U.S. Federal Reserve. Whether you’re in the USA or elsewhere, the impact of rising interest rates on firms and the broader economy can be severe, and requires robust planning responses. 

Rising interest rates are designed to tackle inflation by reducing demand. The cost of borrowing increases which impacts cash flows for firms and consumers alike, eroding economic growth and financial performance of businesses. Further, as equity markets decline around the globe (US equity markets have declined around 20% from their peak), consumer wealth is declining.

All this means we’re in for a rough ride ahead. Here’s what we as planning professionals can do to understand what is happening to our demand and mitigate the impacts of rising interest rates on our businesses.

What Rising Interest Rates Mean for Demand Planners

One thing is for sure – customer and consumer behaviors are changing in the face of attempts to dampen inflation. Time series models are typically used when forecasting demand in the short term but their accuracy is eroding rapidly in the current environment of volatility and of demand pattern change.

If our usual forecasting techniques are not working, we need a different approach

The accuracy of these methods is dependent upon the recurring patterns of demand through time and assumes that the factors affecting demand are stable. We have seen how COVID has disrupted these patterns and we are seeing it again with Central Banks’ efforts to reduce inflation with increased interest rates. If our usual forecasting techniques are not working, we need a different approach.

Start Discussing the Drivers of Demand

Using historical time series data for estimating demand will be a risky proposition under the current circumstances. It is time for us to analyse and evaluate how the evolving economic and financial conditions are affecting our consumers, customers, and business. Collaboration is essential in gaining different perspectives on the situation and how behaviors are changing. [Ed: More on understanding changing consumer behavior here]

Develop hypotheses regarding the current drivers of behavior

The place to start is to develop an ongoing conversation and exploration with experts inside and outside of the company. This allows us to develop hypotheses regarding the current drivers of behavior that underline demand.

Test Alternate Drivers of Demand With Regression Analysis

Regression analysis can be an excellent means of evaluating and testing alternative drivers of demand that result from these discussions. It can also measure the degree of influence that each driver has on demand, both individually and collectively. The variables identified can be deployed to simulate alternative scenarios given assumed conditions that the demand forecaster wants to evaluate.

Regression analysis is an excellent means of testing alternative drivers of demand

The assumed conditions result from gathering information, experiences, and expectations from customers, consumers and related industry experts. This qualitative information is key in a collaborative process where one is dealing with shifting conditions and customers are adapting to new circumstances. Having this qualitative information gathered as part of the demand forecasting and planning process is essential when prevailing conditions make assumptions of time series models invalid.

Tap Sales & Marketing for Insight

Two of the best internal sources of customer and consumer behavior information are Marketing and Sales. Quite often they are fielding research that provides key insights into behavioral shifts and changes. These field studies in conjunction with their professional experience in market facing roles can be a valuable source of information which can improve the quality of demand forecasts and plans.

Used in conjunction with the regression analytics, this can marry quantitative and qualitative demand information. Diversity of perspectives and opinions is an important dimension that time series projections cannot capture during times of momentous change and behavioral shifts.

Things You Can Do Now

Act now: Review your demand forecasting and demand planning processes. Expand the qualitative information dimensions of these processes and develop regression analysis and modeling activities to capture how consumers and customers are reacting to current circumstances.

Collaborate: Expand the breadth of collaboration to add market information research to your demand forecasting efforts. Continuously update this information to track behavioral adaptations of your customers and consumers. Seek out information and opinions from stakeholders.

Be Dynamic: Be prepared to roll with changes. The situation requires a dynamic rather than a static mindset to capture the evolving conditions affecting customer and consumer demand.

Scenario Plan: Develop alternative scenarios and contingency plans. Think in terms of hedging where possible. Collaborate on multiple fronts – demand planning’s efforts in this regard can aid in informing marketing and sales strategies that respond effectively to changing demand. [Ed: More on scenario planning in high interest rate environments here]

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Businesses run in an environment of change and evolution that has multiple dimensions – Economic, Sociological, Political, Competitive, Regulatory, and Technological. At the very heart of the drive for business success is the customer/consumer demand for the company’s products. Indeed, a company’s revenue is a mirror reflection of said demand and all factors that affect it. Understanding consumer behavior, therefore, is of paramount importance.

Demand for a company’s products and services ebb and flow with a complex mix of seasonal, cyclical, and life cycle effects. As Forecasters and Demand Planners, how do we best structure our forecasting and planning efforts in this fluid and often volatile environment?

1. Gather Information From Market Facing Colleagues

This is to discuss ideas with those who are interacting both directly and indirectly with customers and consumers. We want to explore their experience and thinking regarding why and how purchase decisions are made, and what they think the most important considerations are in the purchase decision process. Marketing, Sales, and Product Management professionals can be especially helpful in their perspectives.

The primary purpose of this is to not only evaluate key factors that may help us to forecast, but to explain the variation in patterns of demand that have been historically experienced. Analytics methods – both qualitative and quantitative – are valuable tools that help characterize and explain purchase behaviors of both customers and consumers.

2. Review Qualitative Inputs

Review the findings from our discussion with our colleagues in Marketing, Sales, and Product Management. This can be a collaborative forum or meeting/s that happen ahead of the formal S&OP process. Organize their insight about sources of demand variation and gain consensus from the various stakeholders. This is a forum for feedback and exploration that can refine the conclusions, challenge our hypotheses, and prevent misconceptions about customer and consumer behaviors.

3. Create Scenario Models 

Once we have an understanding of the different demand drivers, we can generate scenario models that incorporate said demand variables. Scenario models help us understand how demand for our products will look in different situations that may arise in future.

For example, we could generate models with unique assumptions regarding periods of economic growth, economic recession, business cycle stages, product lifecycle stages, demographic shifts, population rates of change, product pricing, supply chain issues, business sector consolidation, and more.

Pick the assumptions that are relevant to your business and you’ll have an understanding of what could happen in different scenarios. Adaptation to rapidly changing conditions means that we should not think of purchase behavior from a steady-state or static perspective. We need to have a portfolio of explanatory and forecast models that we can access to quickly pivot and adapt.

Conclusion

It is important that we understand our customers and consumers. We should understand their motivations, needs, purchase decision process, and probable response to changing conditions affecting them. We should create scenarios of behavior under a variety of alternative assumptions.

We should be observant. We should be ready. We should be prepared. The above approach improves the performance of demand forecasts, supporting the company in its efforts to increase operational and financial performance.

2022 is beginning with substantial uncertainty and risk for businesses of all types. Much of this comes from the financial markets, and part of it relates to operating for 2 years in the pandemic. The list is long, but the main risks for demand planning and supply chain management are rising interest rates, shifting currency exchange rates, and price and cost inflation.

The interest rate risk is heightened by the planned normalization policies of central banks, including the Federal Reserve Bank of the U.S. Interest rates have been kept exceptionally low by central banks around the world, going back to the Financial Crisis more than 12 years ago. Rising inflation is forcing central banks to unwind their positions after years of accumulation and to increase their lending rates to banks.

Interest Rate Hikes Mean Changes In Demand

These will affect the cost of borrowing for businesses and consumers alike, in turn affecting the cost of inventory as well as the demand for products by businesses and consumers. For consumers who are acquiring products using debt (borrowing and leasing), the ramifications of higher interest rates can have magnified effects. Interest rates also impact currency exchange rates, adding more risk for global supply chains.

Scenario Planning To Mitigate Financial Risk

Now is the time for Demand Planners and Supply Chain Planners working within FP&A to begin developing risk scenarios for their companies, and to develop strategies to mitigate the financial effects for each. Given the number of risk elements for 2022, and the diversity of their effects by company and industry, scenario testing and planning is especially important. Contingency plans are essential in responding to changing conditions that will alter your product demand and business operations.

How Will Your Customers Respond To Interest Rate Hikes?

Consider how customers and consumers are likely to respond to interest rate changes and inflation in their budgets. For companies in your supply chain, how might they attempt to protect their margins with pricing that affects your costs of operation and your inventories? Consider how you can protect margins with price changes, and how that may affect demand for your products. Given the global nature of our businesses and the effects of currency exchange rates, how might company costs be affected by the coming changes in interest rates?

So, the scenario development and testing, and the development of contingency plans should be systematically undertaken. These should look at the effects on product demand, the effects on operational costs, the effects on inventory costs and financing, and how any ‘margin protection’ actions will impact demand.

How Will Your Responses To Risk Impact Your Trading Partners?

These issues you are facing are shared across all companies in the industry, and across all companies in your supply chain. The responses of each can be additive or multiplicative so Demand Planners need to create scenarios that fully incorporate the risk factors and understand the impacts of any resulting actions on our trade partners, as well as the effects of any actions taken by our suppliers and customers and consumers. Such scenario planning requires cross-functional participation to capture the many possible outcomes and risk factors. FP&A is essential to dollarizing each scenario and each course of action.

FP&A Must Dollarize Each Scenario & Response

Set-up a working group on a cross-functional basis with FP&A taking the lead in putting a dollar value on each scenario and response. This is not an operations forecasting process, but a scenario and contingency planning process. It is important for all members of the working group to realize this. Identifying the interacting elements and their effects on one another is essential. The process and the considerations are dynamic in nature, and will require iterations to test and evaluate the resulting scenarios.

Review these as a group on a regular basis to ensure prompt implementation of contingency plans and action. It is important to be prepared and it is essential to respond to the changing conditions on the ground in a proper and prompt manner.

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After many years of absence, cost and price inflation is returning as a risk factor for business performance. This has major implications for Demand Planners and supply chain professionals.

Central banks are re-assessing their monetary policies and programs to be ready to mitigate inflationary pressures in the economy. Financial markets are girding their loins for uncertainty in the bond and equity markets. Businesses are experiencing strong upward price pressures on energy, transportation, labor, supply, and materials costs.

Profit margins and ROI’s are at risk as businesses begin their financial mitigation efforts in this new and uncertain environment of post-Covid operations.

US inflation is  2-3 times the average annual rate experienced over the past 15 years

Currently, overall inflation in the U.S. is about 2-3 times the average annual inflation rate experienced over the past 15 years. Inflation for some key commodity categories like oil is much higher than that.

Supply chain management is experiencing rising costs due to commodity and factor prices along with delays and disruptions in shipping and transportation that are extending lead times and increasing inventory during this post-Covid adjustment period. Service and product pricing will need to be adjusted to reflect this to protect product margins and ROI.

Product costs are also rising due to materials and labor expenses, and other expenses which are essential to production. These too will contribute to adjustments in pricing to preserve margins. Higher inventories will result in higher interest, handling and warehousing costs, and other costs associated with holding stock. This will partially consume the free cash flow that would have been available in the pre-Covid world. And of course, there are also higher costs associated with Covid protocols essential to protecting employees, clients, and customers.

How Inflation Impacts Consumer Demand

Everyone working in supply chain has these same issues to deal with. There are inflationary pressures being experienced across and up-and-down the supply chain network. How is all this cost and pricing pressure going to affect the demand for products?

Enter the world in which Demand Planners are trying to understand the demand for products and services as household incomes change and as consumer behavior changes. Changing prices will affect demand patterns. The accuracy of demand forecasts directly affects the accuracy and mitigation activities of Supply Planners.

Inflation alters consumer behavior in ways that tend to increase demand volatility

Inflation also alters prices and consumer behavior in ways that tend to increase demand volatility and decrease demand forecast accuracy. So, the inflationary threats at hand are of critical concern to those who are doing the demand forecasting and demand planning as well as those who are using them in the supply planning and supply chain management.

Inflation Requires More Advanced Analytics

In times of low inflation and steady financial market conditions, it is easier for demand forecasters to accurately forecast demand with the many time series models available, which yields acceptable results with relatively simple methodologies. In current times, it is important to better understand consumer behavior and its reaction to changing household financial circumstances and economic conditions. This necessitates more complex analytics and more complex forecasting models such as regression.

Inflation necessitates more complex forecasting models such as regression

Now is the time for Demand Planners to focus more time and attention on gathering data and market intelligence from prior periods to better evaluate the factors that are currently driving demand. This can then be used with regression analysis and regression models to better explain the behavior of customers and consumers as their circumstances change. It provides an opportunity to simulate future outcomes and future scenarios of behavior instead of assuming relative stability of conditions as time series methods do.

This aids in gaining greater insight into likely product demand when prices and consumer income (in real terms) are changing. This can increase the reliability of projections used in supply management in periods of inflation.

Pricing Strategies Are Important In Inflationary Times

Since relative price is a key factor in purchase behavior, it will be important for Demand Planners to undertake analytics that test the price elasticity of demand and the associated pricing strategies to get the best financial results for the company.

It will be important for Demand Planners to undertake analytics that test the price elasticity of demand

Price strategies and market responsiveness to competitor actions are essential when competitors and inflation are simultaneously affecting the relative price of the company’s products. Marketing plans must be carefully considered when there are both company-controlled and market-controlled variables affecting demand.

Now is the time to increase collaboration across functions, increase use of qualitative methods to understand consumer behavior, and specifically focus attention on the multiple dimensions of inflationary effects that may influence product demand.

In Summary

Inflation is a condition which has been tempered for many years and is now a complicating consideration again. There is the question of whether it is a transitory condition due to the post-Covid transition, or if it may have a more long-term nature like it used to have in years gone by. Either way, its a reality that cannot be ignored by Demand Planners or supply chain professionals. Quality demand forecasts adapted to changing consumer behavior and thoughtful supply chain management will be essential to realizing the financial goals of your company and serving the needs of its customers.

 It is important for both supply chain and financial professionals to consider the impact of mitigation and risk management efforts on company financial performance. Projected demand for upcoming periods must be planned for, and we look to balance supply and demand using demand forecasts and collaborative planning forums like S&OP or IBP.

In S&OP/IBP, business considerations and issues will be brought to the table that represent risks to the organization from operational and financial perspective. Strategies and mitigating actions are essential and should be chosen considering the expected financial consequences for the company.

The finance function is a key stakeholder in such forums as they supply information and financial analytics that can be used to ensure that all operations can be financed effectively and that decisions made contribute to a competitive ROI for the business. They are an essential part of the team in estimating and evaluating the alternative risk management alternatives available for risk mitigation strategy actions. Finance and supply chain functions have a shared responsibility for supporting the S&P/IBF processes.

Variation in demand as well as supply chain considerations can contribute to the need for safety stock, for example. It may require higher inventory and more points of distribution for the achievement of the desired level of customer service. It may require supply chain adjustments and mitigation that effect the business economics and business risks. Mitigations most often have financial effects – positive and negative – on the company. This kind of risk mitigation can be expensive.

Demand and sales forecasts are the platforms from which supply planning is launched. We are basing the supply chain structure, plans, and operations on these demand forecasts that then affect revenue and operating profit. Supply chains have a myriad individual supply links that interact with other links in the chain and with other supply chains. There are a host of supply chain risks to be hedged, mitigated, managed, and financially evaluated.

There are risks related to:

Disruptions: Supplier bankruptcies, natural disasters, and labor disputes.

Delays: Inflexible supply sources, capacity utilization, border crossings, customs.

Information Systems: System integration issues, networking problems.

Procurement: Exchange rates, single source materials, components, finished products for resale.

Inventory: Demand and supply volatility and uncertainty, excess and obsolete inventory, inventory holding costs.

Capacity:  Cost of capacity, cost of flexibility, capacity utilization rates, production flows and set-up, operational and financial condition of supply chain partners.

Lead Times and Related Volatility: Transportation, production, assembly, shipping components, supplies, raw materials, work in progress, finished products.

Demand Forecast Error: Excessive promotional activity, innately high volatility of demand, poor handling of data and information, poorly organized and poorly managed forecasting process, excessive forecast overrides and bias, lack of collaboration, key function participation

There are supply chain management mitigation approaches widely used for demand and supply related risks:

1. Increased capacity engagement through redundant suppliers
2. Increased oversight and responsiveness
3. Increased inventory and working capital
4. Increased company and supply flexibility
5. Aggregated demand to reduce uncertainty & forecast error

The mitigation approaches may result in increased product costs, operational costs, transportation costs, distribution costs, warehousing costs, and other supply chain management expense areas. Without the beneficial effects of higher revenue through volume and pricing, the mitigation approaches in isolation will probably have an adverse P&L effect.

They may reduce Net Operating Income, Net Income, and Cash Flow from Operations. So, it is important with support from the financial function to estimate financial effects and plan for actions that aid in improving other areas of the P&L – topline and/or expense – to achieve financial balance.

Impact On The Balance Sheet

Where the mitigations require investment in working capital and long-term capital assets, the balance sheet effects come to the fore. The investments will generally reduce cash, increase inventory, increase fixed assets, increase debt and the associated interest expense.

The Return on Assets and the Return on Equity are both impaired due to the reduced Net Income experienced by the company. The Return on Assets is further impaired by the combination of lower Net Income and higher Total Assets. So, again it is important to find other areas of the P&L and of the Balance Sheet with the support of the financial function where improvements can be made to balance the effects of the mitigation approaches on these key return metrics for the company.

Risk Mitigation Requires Collaboration

Throughout our demand planning and supply chain management efforts, we are dealing with volatility and other sources of risk to the business. The challenge is to be able to mitigate and hedge risks while producing a return on investment for the company.

This requires sharing of information and ideas, collaboration, and cooperation, as well as systematic analysis of costs and benefits expected from the mitigation actions that may be taken. It also requires both a short-term and a long-term perspective in our decision-making processes. The S&OP and the IBP processes are forums within which to do this.

We must consider the financial effects of our demand management and supply chain management activities on the operational and financial success of the company. We cannot do this in isolation. It is important to develop a relationship of collaboration with the finance function of the company to take part in our forecasting and planning processes, providing financial information, analytics, and financial counsel. This can help to realize an effective working relationship that balances the considerations of supply chain efficiency and operations, as well as financial ramifications and competitive financial performance for the company.

For further information on how Finance can benefit from collaboration with demand planning, click here.